The Economic Significance of Trading Based on the Size Effect in Australia

Posted: 5 Feb 2012

See all articles by Jenni L. Bettman

Jenni L. Bettman

Australian National University (ANU)

Stephen Sault

Australian National University (ANU); Financial Research Network (FIRN)

Date Written: April 8, 2011

Abstract

It is generally accepted within the extant literature that a size effect exists, whereby smaller firms tend to experience higher rates of return than those of large firms. This small size effect is identified in a number of studies over a variety of equity markets. Despite this, however, no study to date considers the dollar profits attainable by executing a trading strategy that constructs a portfolio based on stocks within the lowest market capitalization decile. Specifically, this paper seeks to identify the existence of a size effect in Australia, but, moreover, attempts to ascertain if a dollar profit can be obtained from executing a trading strategy based on small market capitalization stocks. In doing this, we consider all stocks listed on the Australian stock exchange, and use volume and bid-ask prices to account for liquidity and transactions costs, respectively. Overall, our regression analysis confirms the existence of a size effect within the Australian equity market. However, in executing a trading strategy based on stocks with low market capitalization, we find that after accounting for liquidity and transaction costs the profits obtainable are extremely small and statistically insignificant. This suggests that while the firm size effect exists, the illiquidity and relatively large transaction costs of small stocks eliminate the potential for economic profits.

Keywords: economic significance, size effect

Suggested Citation

Bettman, Jenni L. and Sault, Stephen, The Economic Significance of Trading Based on the Size Effect in Australia (April 8, 2011). Australian Journal of Management, Vol. 36, No. 1, 2011, Available at SSRN: https://ssrn.com/abstract=1998723

Jenni L. Bettman (Contact Author)

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Stephen Sault

Australian National University (ANU) ( email )

Canberra ACT 0200, 2601
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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